Public Builders Likely to See Mild Recovery in 2010

A four-year downturn has evidently come to an end for U.S. homebuilders, according to Fitch Ratings in its outlook report for the sector.

While Fitch maintains a negative outlook for U.S. homebuilding in 2010, the expected conclusion of the national housing credit has positively influenced housing data over the last few months. Pending home sales, existing home sales, single-family housing starts and single-family new home sales have been generally showing improvement after bottoming out earlier this year. The same holds true for new home inventories, home pricing and consumer and builder sentiment. “Importantly, the U.S. economy apparently moved from recession to expansion in the third quarter of 2009,” said Bob Curran, Fitch’s managing director and lead homebuilding analyst. “However, challenges remain, especially the expected upcoming surge in delinquencies and foreclosures for both alt-A and option adjustable-rate mortgages.

Fitch raised its forecasts for starts and new home sales earlier this year, the first positive adjustments in these metrics in over three years. Nevertheless, Fitch anticipates that the early stages of this expansion may be more muted than the average.”

During the first 12-15 months off the bottom, the recovery may appear jaw-toothed as substantial foreclosures now in the pipeline present as distressed sales, and as meaningful new foreclosures arise from alt-A and option ARM resets, he said.

High unemployment rates and the probable tightening of certain FHA loan standards (higher minimum credit scores for new borrowers and greater upfront cash requirements) will be notable headwinds early in the upcycle.

“The continuation and expansion of the national housing credit should partially help offset expected seasonal declines during the winter months through the spring of 2010,” said Mr. Curran. “The federal government’s continuing efforts to moderate foreclosures may also show some success in 2010.”

Despite having fewer competitors, public builders will continue to be challenged and need to maintain tight controls over costs and expenses during 2010. Fitch expects that the public builders by and large to typically stabilize their aggregate land positions over the next six to 12 months or selectively add to owned, developed lot holdings.

“With operational and financial pressures moderating to some extent,most public homebuilders have to operate successfully within this still-challenging environment or wither away,” he said.

Companies have to at least maintain current cost profiles or continue to downsize to the point where they can remain/be profitable. That means possible further moderate cuts in staffing and other overhead, as well as other cost reductions.

The builders’ gross profit margins and selling, general and administrative expense/sales ratios will confirm the success of their efforts. The public homebuilders cannot significantly influence revenue trends and profitability at present, but they can manage their balance sheets and their liquidity, he said.

In a period when liquidity is still an issue for all U.S. companies, Fitch believes that, overall, the U.S. homebuilding sector has adequate liquidity. For certain builders, cash flow has been enhanced by relatively recent debt offerings, large land sales, tax refunds and even some public equity offerings (e.g., Meritage Homes Corp., Hovnanian Enterprises Inc., Lennar Corp. and M/I Homes Inc.) or other external cash infusions (Standard Pacific Corp.).

Recently passed legislation that extends the net operating losses carry back to offset taxable profits from the previous five years will result in meaningful tax refunds for most public homebuilders early in 2010, further enhancing liquidity and tangible net worth, he said.

All the public homebuilders in Fitch’s coverage that have revolving credit facilities have unsecured facilities, except for Beazer Homes USA Inc., M/I Homes and Standard Pacific, which have secured or partially secured revolving credit facilities. D.R. Horton Inc., Ryland Group Inc., Meritage and Hovnanian recently terminated their revolving credit facilities. Beazer and Standard Pacific have sharply lowered the size of their credit facilities.

Despite the negative outlook for the sector, continued progress in industry and company metrics could prompt a reassessment and possible revision of some of the U.S. homebuilder rating outlooks. Fitch forecasts U.S. GDP to fall by 2.5% this year, and unemployment to possibly touch 10.3% in 2010.

With unemployment still rising, consumer confidence at low levels and household wealth until recently still being affected by real estate and equity price declines, there seems limited prospect that the deleveraging process will end in the near term. Fitch’s forecasted 1% decline in consumer spending in 2009 implies a further increase in the saving ratio.

Fitch expects the economy to return to positive growth next year, primarily reflecting the impact of the fiscal stimulus package, but also some likely stabilization in housing investment and a weakening inventory overhang.

Fitch’s initial outlook for the housing sector in 2009 started quite bearish due to the influence of a softening economy, even tighter credit standards for homebuyers and the effect of late 2008 disruptions in the credit markets. However, by midyear the outlook brightened, prompting lesser forecast declines for a number of housing metrics.

Fitch most recently forecast a contracting economy during the first half of 2009, with a mild recovery beginning in the third quarter and continuing through 2010. Real GDP is forecast to decrease 2.5% for all of 2009. Investment is expected to plunge 17.6%, with consumer spending to fall 1%, exports to drop 11.6% and imports to see a 16.6% decline.

The MBA and John Burns Real Estate Consulting forecast 2.76 million annual foreclosure starts in 2009, up from 2.27 million in 2008, and project 2.94 million foreclosure starts in 2010. The Center for Responsible Lending forecasts 2.43 million foreclosures in 2009 and 8.1 million foreclosures over the next four years.

Various programs from Washington are designed to stimulate the economy, stem foreclosures and improve housing demand. However, these actions are unlikely to stabilize and then boost housing demand until later in 2010 or beyond.

In 2009, total housing starts are projected to fall 41.1% to 530,000 with single-family volume declining 30.6% to 430,000. New home sales are forecast to decrease 23.1% to 373,000, while existing home sales are flat at 4.91 million.